ULIPs (Unit Linked Insurance Plans) are one of the most common investments made today, acting as a preferred financial tool for people across age groups. Additionally, they provide a variety of tax advantages (u/s 80C and 10D of the Income Tax Act) and the freedom to customize your investments in accordance with your unique financial priorities and goals. However, did you know that ULIP plans can also be divided into two categories: Type 1 and Type 2 ULIPs? Although each ULIP type has its unique benefits, it is crucial first to comprehend how they work and how they might help you achieve your financial objectives. Therefore, let’s take a closer look at Type 1 and Type 2 Unit Linked Insurance Plans to understand their benefits and differences.
Delving deeper into the types of ULIP plans
Being a hybrid financial product that provides a mix of investments and insurance, Unit Linked Insurance Plans are often looked at solely from an investor’s perspective, where their features, like fund switching, partial withdrawals, etc., are highlighted and considered while buying them. But, that is not the complete picture of a ULIP, meaning that there is the insurance component as well, where a death benefit (sum assured) is paid out to the policyholder’s nominees in case the policyholder meets an untimely demise during the policy term. The distinction between ULIPs is made based on the death benefit they pay out.
1. ULIP Type 1 Plans
In case of the tragic event that the policyholder passes away within the policy period, the insurance company for a ULIP Type 1 plan pays the beneficiaries either the original sum assured or the final fund value of the ULIP. Depending on the higher value, the sum assured or the fund value is paid out as a death benefit.
Let’s say, for example, that you have made premium payments for your ULIP Type 1 plan, with a sum assured of Rs. 50 lakhs. In the meantime, your ULIP’s fund value has also been increasing with steady returns. Hence, as mentioned, the death benefit paid out to your beneficiaries will be the higher sum of the two. Suppose that the fund value is Rs. 30 lakhs to date. Then the sum assured, i.e. Rs. 50 lakhs will be paid out to your beneficiaries in this case. However, suppose the fund value is Rs. 60 lakhs. In such a scenario, Rs. 60 lakhs is the amount that will be paid to your beneficiaries under this kind of plan.
2. ULIP Type 2 Plans
The beneficiaries of a ULIP Type 2 plan receive the sum assured in the tragic event of the policyholder’s untimely demise within the policy tenure. As a result, the death benefit paid out is the amount guaranteed by the ULIP.
Using the above example, let us assume that your sum assured is Rs 50 lakhs. Your beneficiaries will receive this amount as the death benefit from the insurance company in a straightforward mechanism. This is how Type-2 plans work.
Type 1 and Type 2 ULIP differences –What stands out?
ULIP plans vary according to various aspects, including the kind of insurance coverage provided, the invested premium amounts, the premium payment methods, and the ULIP’s investment goals. As mentioned, the distinction between Type 1 and Type 2 ULIPs is determined by the death benefit that the insurer pays out. This results in some apparent differences between the two types of ULIP policies.
- Firstly, as we can see from the aforementioned instances, there are various ways in which the death benefit is computed. The higher of the two among the sum assured or fund value is considered the death benefit payout in the case of Type 1 ULIP plans. On the other hand, the sum assured under the policy is regarded as the sole payout in Type 2 ULIP policies.
- Secondly, the “sum at risk” varies across these two categories. In the case of a Type 1 ULIP, the insurer must pay the greater of the sum insured or the fund value as a death benefit. This translates to a yearly decrease in the insurer’s risk of paying out due to your fund’s increasing value.
- For Type 2 ULIPs, however, the insurer must pay the death benefit equal to the amount assured. Therefore, even as your fund value increases and surpasses the sum assured, the amount at risk for the Type 2 ULIP remains constant over time.
To Sum Up
ULIPs are the go-to options for many people today, particularly for their dual benefits of insurance and investments and, of course, their flexibility when it comes to choosing your investments and extensive features like fund switching and premium redirection that make it investor friendly. Whether you choose a Type 1 or Type 2 ULIP, you can always tailor your policy to meet your future financial objectives.